Economics 330Lecturer: Elizabeth Kelly

Economics 330Lecturer: Elizabeth Kelly

First MidtermOctober 2, 2000

INSTRUCTIONS:

1. Put your name, UW ID number, and discussion section on each of the two bluebooks.
2. Write “short answers” on the cover of one bluebook.
3. In this bluebook, answer two of the identification questions.
4. In this same bluebook, also answer three of the short response questions.
5. Write “essays” on the cover of the second bluebook and write answers for two essay questions in it.
6. Use the indicated times to guide your efforts. There are 50 minutes. Two exam points are associated with each minute.

Discussion Sections:

Identifications: (8 minutes) Identify and briefly explain the importance of any TWO(2) of the following:

1. Liquidity
2. Financial intermediation
3. Systematic risk
4. Indirect finance

Short Responses: (18 minutes) For any THREE (3) of the following statements, state whether you AGREE, DISAGREE, OR CANNOT DECIDE. Explain your position in a paragraph. Your grade will be based largely on your explanations.

1. When the amount of loanable funds increases, we can anticipate that interest rates on bonds will decrease.
2. Thirty-year Treasury Bonds are more risky than T-Bills. (Assume you are investing for retirement in 30 years.)
3. When the rate of growth of the money supply decreases, the interest rate increases.
4. The cost of borrowing increases one-for-one with the interest rate.
5. An increase in the current yield always corresponds to an increase in the yield to maturity.
6. Contractual savings institutions predominately invest in capital market assets.

Essays: (24 minutes) In your SECOND BLUEBOOK, answer any TWO (2) of the following:

1. What is asymmetric information and how does it create problems both before and after the transaction? Provide and interpret two illustrative examples: one that is an example of asymmetric information before the transaction and the other that is an example of asymmetric information after the transaction.
2. The measurement of money through the monetary aggregates provides a quantitative measure of the amount of money circulating in our economy. Briefly describe the difference between the theoretical approach to measuring money and the empirical approach. In the empirical approach, compare and contrast the different monetary aggregate measures that the Fed provides. Select the monetary aggregate you think is the best measure of the money supply and then provide a discussion of why you selected this one.
3. Suppose you are in a high-inflation regime: the current nominal interest rate is 50%, the expected inflation rate for the next four years is 30% per year, and the nominal interest rates are expected to similarly increase by 30% per year. What is the real interest rate for each of the next four years? If you purchase a five-year indexed bond with an initial annual coupon payment of 10% of the face value, and a face value of $1000, what do you expect the dollar amount of your fourth coupon payment be? Assuming you plan to hold the bond to maturity, is the interest rate on the indexed bond a good measure of your expected return?
4. In the theory of portfolio choice, what are the determinants of asset demand? What is the relationship between each of these determinants and the quantity demanded?